Homeowners who want to refinance their mortgages are making a mistake if they feel bound by the 2 percent rule for refinancing, a growing number of real estate experts now say.
The 2 percent rule, a time-honored maxim in real estate, holds that refinancing a mortgage usually doesn't pay off for a homeowner unless the refinancing interest rate is at least two percentage points below the interest rate of the homeowner's existing mortgage.
"The 2 percent differential is a fallacy," said Richard A. Rosenberg, president of Vision Mortgage Corp. of North Brunswick, which also has offices in King of Prussia and Toms River, Pa. "Homeowners who follow the old rules may be passing up an opportunity to save a substantial amount of money."
Mr. Rosenberg said some homeowners can save a significant amount of money if they refinance with only a 1 percent or even a one-half percent gap between the existing and refinancing rates. He said about 30 percent of the current refinancings by Vision are "at differentials of 1 percent or less."
Mr. Rosenberg is among a growing number of people in the industry who have begun advising homeowners to base refinancing decisions on actual calculations rather than the old rule. Several real estate consultants now also have begun advocating that the 2 percent rule should be ignored, including Peter G. Miller of Silver Spring, Md., author of several best-selling real-estate books, and David Ginsburg, president of Loantech Inc. of Gaithersburg, Md., a mortgage consulting firm.
Mr. Rosenberg said there has been a "new wave" of refinancing in recent weeks, with interest rates for mortgages at their lowest level in more than 20 years.
Some area lenders last week offered 30-year fixed-rate mortgages at interest rates as low as 6.25 percent, according to Mortgage Reporting Services of Jenkintown, Pa. In most cases, an upfront fee of three points is charged to get the 6.25 percent rate. Each point is equal to 1 percent of the amount of the loan, or $3,000 for a $100,000 loan.
"If you have a 30-year, $120,000 mortgage with an interest rate of 8.5 percent, the monthly payment is $922.70," Mr. Rosenberg said. "If you refinance at 7.5 percent, your monthly payment would be $839.10, or an extra $83.60 in your pocket each month."
Mr. Rosenberg said the key components of the formula for deciding when to consider small-gap refinancing are:
* The size of the mortgage.
* The amount of equity the owner has in the home.
* The amount of closing costs or expenses for the new loan.
* The length of time the homeowner plans to remain in the home.
"The higher the mortgage amount, the lower the interest rate differential at which refinancing makes sense," Mr. Rosenberg said.
Refinancing also can pay off when homeowners have equity in their homes equal to at least 20 percent of the appraised value of the homes, he said. A homeowner with that much equity won't have to pay for private mortgage insurance, which covers the lender in case the borrower defaults, as part of the refinancing closing costs.
Mr. Rosenberg said mortgages with no points or low points offer the best opportunity for successful refinancing when there is a slim gap between the refinance rate and existing rate, since this also helps keep refinancing costs down. No-point, 30-year mortgages currently have fixed interest rates of about 7.25 percent, he said.
If a homeowner chooses a no-point mortgage and has at least 20 percent equity in the home, closing costs in a typical refinancing will come to $1,100 to $1,700, Mr. Rosenberg said. Closing costs vary, but can include an application fee, settlement charge by the title company, title search, title insurance, recording fee and appraisal fee.
For the last element of the equation, the homeowner must decide how long he or she will continue to own the home, Mr. Rosenberg said. The length of stay determines how long it takes to pay off the closing costs and begin to get a payback from the lower monthly mortgage payments.
The longer the stay, the more payback.